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The Globalization and Monetary Policy Institute Working Papers
2009 | 2008 | 2007
2009
No. 39
State-Dependent Pricing, Local-Currency
Pricing, and Exchange Rate Pass-Through
Anthony Landry
Abstract: This paper presents a two-country DSGE model with state-dependent pricing as in Dotsey, King, and Wolman (1999) in which firms price-discriminate across countries by setting prices in local currency. In this model, a domestic monetary expansion has greater spillover effects to foreign prices and foreign economic activity than an otherwise identical model with time-dependent pricing. In addition, the predictions of the state-dependent pricing model match the business-cycle moments better than the predictions of the time-dependent pricing model when driven by monetary policy shocks.
No. 38
A Model of International Cities: Implications for Real
Exchange Rates
Mario J. Crucini and Hakan Yilmazkuday
Abstract: We develop a model of cities each inhabited by two agents, one specializing in manufacturing, the other in retail distribution. The distribution sector represents the physical transformation of all internationally traded goods from the factory gate to the final consumer. Using a panel of micro-prices at the city level, we decompose the cross-sectional variance of long-run LOP deviations into the fraction due to distribution costs, trade costs and a residual. For the median good, trade costs account for 50 percent of the variance, distribution costs account for 10 percent with 40 percent of the variance unexplained. Since the sample of items in the data are heavily skewed toward traded goods, we also decompose the variance based on the median good on an expenditure-weighted basis. Now the tables turn, with distribution costs accounting for 43 percent, trade costs 36 percent and 21 percent of the variance unexplained.
No. 37
Global, Local, and Contagious Investor Sentiment
Malcolm Baker, Jeffrey Wurgler and Yu Yuan
Abstract: We construct indexes of investor sentiment for six major stock markets and decompose them into one global and six local indexes. Relative market sentiment is correlated with the relative prices of dual-listed companies, validating the indexes. Both global and local sentiment are contrarian predictors of the time series of major markets' returns. They are also contrarian predictors of the time series of cross-sectional returns within major markets: When sentiment from either global or local sources is high, future returns are low on various categories of difficult to arbitrage and difficult to value stocks. Sentiment appears to be contagious across markets based on tests involving capital flows, and this presumably contributes to the global component of sentiment.
No. 36
Can Long-Horizon Forecasts Beat the Random Walk Under the Engel-West Explanation?
Charles Engel, Jian Wang and Jason Wu
Abstract: Engel and West (EW, 2005) argue that as the discount factor gets closer to one, present-value asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and exchange rates appear to follow approximately a random walk. We connect the Engel-West explanation to the studies of exchange rates with long-horizon regressions. We find that under EW's assumption that fundamentals are I(1) and observable to the econometrician, long-horizon regressions generally do not have significant forecasting power. However, when EW's assumptions are violated in a particular way, our analytical results show that there can be substantial power improvements for long-horizon regressions, even if the power of the corresponding shorthorizon regression is low. We simulate population Rsquared for long-horizon regressions in the latter setting, using Monetary and Taylor Rule models of exchange rates calibrated to the data. Simulations show that long-horizon regression can have substantial forecasting power for exchange rates.
No. 35
European Hoarding: Currency Use Among Immigrants in Switzerland
Andreas M. Fischer
Abstract: Do immigrants have a higher demand for large denominated banknotes than natives? This study examines whether cash orders for CHF 1000 notes, a banknote not used for daily transactions, is concentrated in Swiss cities with a high foreign-to-native ratio. Controlling for a range of socio-economic indicators across 250 Swiss cities, European immigrants in Switzerland are found to hoard less CHF 1000 banknotes than natives. A 1 percent increase in the immigrant-to-native ratio leads to a reduction in currency orders by CHF 4000. This negative correlation between immigrant-to-native ratio and currency orders for CHF 1000 notes holds irrespective of the European immigrants' country of origin. Hoarding of large denominated banknotes by natives is attributed tax avoidance.
No. 34
Should Monetary Policy "Lean or Clean"?
William R. White
Abstract: It has been contended by many in the central banking community that monetary policy would not be effective in "leaning" against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in "cleaning" up (the bust) afterwards. In this paper, these two propositions (can't lean, but can clean) are examined and found seriously deficient. In particular, it is contended in this paper that monetary policies designed solely to deal with short term problems of insufficient demand could make medium term problems worse by encouraging a buildup of debt that cannot be sustained over time. The conclusion reached is that monetary policy should be more focused on "preemptive tightening" to moderate credit bubbles than on "preemptive easing" to deal with the after effects. There is a need for a new macrofinancial stability framework that would use both regulatory and monetary instruments to resist credit bubbles and thus promote sustainable economic growth over time.
No. 33
Global Slack and Domestic Inflation Rates: A Structural Investigation for G-7 Countries
Fabio Milani
Abstract: Recent papers have argued that one implication of globalization is that domestic inflation rates may have now become more a function of "global," rather than domestic, economic conditions, as postulated by closed-economy Phillips curves. This paper aims to assess the empirical importance of global output in determining domestic inflation rates by estimating a structural model for a sample of G-7 economies. The model can capture the potential effects of global output fluctuations on both the aggregate supply and the aggregate demand relations in the economy and it is estimated using full-information Bayesian methods. The empirical results reveal a significant effect of global output on aggregate demand in most countries. Through this channel, global economic conditions can indirectly affect inflation. The results, instead, do not seem to provide evidence in favor of altering domestic Phillips curves to include global slack as an additional driving variable for inflation.
No. 32
Has Globalization Transformed U.S. Macroeconomic Dynamics?
Fabio Milani
Abstract: This paper estimates a structural New Keynesian model to test whether globalization has changed the behavior of U.S. macroeconomic variables. Several key coefficients in the model—such as the slopes of the Phillips and IS curves, the sensitivities of domestic inflation and output to "global" output, and so forth—are allowed in the estimation to depend on the extent of globalization (modeled as the changing degree of openness to trade of the economy), and, therefore, they become time-varying. The empirical results indicate that globalization can explain only a small part of the reduction in the slope of the Phillips curve. The sensitivity of U.S. inflation to global measures of output may have increased over the sample, but it remains very small. The changes in the IS curve caused by globalization are similarly modest. Globalization does not seem to have led to an attenuation in the effects of monetary policy shocks. The nested closed economy specification still appears to provide a substantially better fit of U.S. data than various open economy specifications with timevarying degrees of openness. Some time variation in the model coefficients over the postwar sample exists, particularly in the volatilities of the shocks, but it is unlikely to be related to globalization.
No. 31
Fiscal Stabilization with Partial Exchange Rate Pass-Through
Erasmus K. Kersting
Abstract: This paper examines the role of fiscal stabilization policy in a two-country framework that allows for a general degree of exchange rate pass-through. I derive analytical solutions for optimal monetary and fiscal policy which are shown to depend on the degree of pass-through. In the case of partial pass-through, an optimizing policy maker uses countercyclical fiscal stabilization in addition to monetary stabilization. However, in the extreme cases of complete or zero pass-through, the fiscal stabilization instrument is not employed. There is also no additional gain from the fiscal instrument in the case of coordination between the two countries. These results are due to the specific way the optimal fiscal policy rule affects marginal costs: Rather than being a substitute for monetary policy, fiscal policy complements it by increasing the correlation of the marginal cost terms within and across countries. This in turn makes monetary policy more effective at stabilizing them.
No. 30
Insulation Impossible: Fiscal Spillovers in a Monetary Union
Russell Cooper, Hubert Kempf and Dan Peled
Abstract: This paper studies the effects of monetary policy rules in a monetary union. The focus of the analysis is on the interaction between the fiscal policy of member countries (regions) and the central monetary authority. When capital markets are integrated, the fiscal policy of one country will influence equilibrium wages and interest rates. Thus there are fiscal spillovers within a federation. The magnitude and direction of these spillovers, in particular the presence of a crowding out effect, can be influenced by the choice of monetary policy rules. We find that there does not exist a monetary policy rule which completely insulates agents in one region from fiscal policy in another. Some familiar policy rules, such as pegging an interest rate, can provide partial insulation.
No. 29
Monetary Policy Strategy in a Global Environment
Philippe Moutot and Giovanni Vitale
Abstract: Since the mid-1980s the world economy has gone through
profound transformations of which the sources and effects are probably not
yet completely understood. The process of continuous integration in trade,
production and financial markets across countries and economic regions—which
is what is generally defined as "globalisation"—affects directly
the conduct of monetary policy in a variety of respects. The aim of this paper
is to present an overview of the structural implications of globalisation for
the domestic economies of developed countries and to deduct from these implications
lessons for the conduct of monetary policy, and in particular the assessment
of risks to price stability.
- Published as "Monetary Policy Strategy in a Global Environment" European Central Bank Occasional Paper, No. 106, August 2009.
No. 28
Investment and Trade Patterns in a Sticky-Price, Open-Economy Model
Enrique Martínez-García and Jens Søndergaard
Abstract: This paper develops a tractable two-country DSGE
model with sticky prices à la Calvo (1983) and local-currency pricing.
We analyze the capital investment decision in the presence of adjustment
costs of two types, the capital adjustment cost (CAC) specification and the
investment adjustment cost (IAC) specification. We compare the investment
and trade patterns with adjustment costs against those of a model without
adjustment costs and with (quasi-) flexible prices. We show that having adjustment
costs results into more volatile consumption and net exports, and less volatile
investment. We document three important facts on U.S. trade: a) the S-shaped
cross-correlation function between real GDP and the real net exports share,
b) the J-curve between terms of trade and net exports, and c) the weak and
S-shaped cross-correlation between real GDP and terms of trade. We find that
adding adjustment costs tends to reduce the model's ability to match these
stylized facts. Nominal rigidities cannot account for these features either.
- Published as "Investment and Trade Patterns in a Sticky-Price, Open-Economy
Model" in The Economics of Imperfect Markets: The Effect of Market
Imperfections on Economic Decision-Making, Giorgio Calcagnini and Enrico
Saltari (eds.), Springer, 2009
No. 27
International Portfolios, Capital Accumulation
and Foreign Assets Dynamics
Nicolas Coeurdacier, Robert Kollmann and Philippe Martin
Abstract: Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation, shocks to the efficiency of physical investment, as well as international trade in stocks and bonds. In our model, domestic stocks are used to hedge fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversification does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital flows.
No. 26
Monthly Pass-Through Ratios
Marlene Amstad and
Andreas M. Fischer
Abstract: This paper estimates monthly pass-through ratios from import prices to consumer prices in
real time. Conventional time series methods impose restrictions to generate exogenous
shocks on exchange rates or import prices when estimating pass-through coefficients.
Instead, a natural experiment based on data releases defines our shock to foreign prices. Our
estimation strategy follows an event-study approach based on monthly releases in import
prices. Projections from a dynamic common factor model with daily panels before and after
monthly releases of import prices define the shock. This information shock allows us to
recover a monthly pass-through ratio. We apply our identification procedure to Swiss prices
and find strong evidence that the monthly pass-through ratio is around 0.3. Our real-time
estimates yield higher pass-through ratios than time series estimates.
No. 25
Do China and Oil Exporters Influence
Major Currency Configurations?
Marcel Fratzscher and Arnaud Mehl
Abstract: This paper analyses the impact of the shift away from a US dollar focus of systemically important emerging market economies (EMEs) on configurations between the US dollar, the euro and the yen. Given the difficulty that fixed or managed US dollar exchange rate regimes remain pervasive and reserve compositions mostly kept secret, the identification strategy of the paper is to analyse the market impact on major currency pairs of official statements made by EME policy-makers about their exchange rate regime and reserve composition. Developing a novel database for 18 EMEs, we find that such statements not only have a statistically but also an economically significant impact on the euro, and to a lesser extent the yen against the US dollar. The findings suggest that communication hinting at a weakening of EMEs' US dollar focus contributed substantially to the appreciation of the euro against the US dollar in recent years. Interestingly, EME policy-makers appear to have become more cautious in their communication more recently. Overall, the results underscore the growing systemic importance of EMEs for global exchange rate configurations.
No. 24
How Successful is the G7 in Managing Exchange Rates?
Marcel Fratzscher
Abstract: The paper assesses the extent to which the Group of Seven (G7) has been successful in its management of major currencies since the 1970s. Using an event-study approach, the paper finds evidence that the G7 has been overall effective in moving the US dollar, yen and euro in the intended direction at horizons of up to three months after G7 meetings, but not at longer horizons. While the success of the G7 is partly dependent on the market environment, it is also to a significant degree endogenous to the policy process itself. The findings indicate that the reputation and credibility of the G7, as well as its ability to form and communicate a consensus among individual G7 members, are important determinants for the G7's ability to manage major currencies. The paper concludes by analyzing the factors that help the G7 build reputation and consensus, and by discussing the implications for global economic governance.
- Published as "How Successful Is the G7 in Managing Exchange Rates?" in the Journal of International Economics, vol 79, issue 1, 2009, pp. 78–88
No. 23
Exchange Rate Pass-Through in a Competitive Model of Pricing-to-Market
Raphael Auer and
Thomas Chaney
Abstract: This paper extends the Mussa and Rosen (1978) model of quality-pricing under perfect
competition. Exporters sell goods of different qualities to consumers who have
heterogeneous preferences for quality. Production is subject to decreasing returns to scale
and, therefore, supply and the toughness of competition react to cost changes brought about
by exchange rate fluctuations. First, we predict that exchange rate shocks are imperfectly
passed through into prices. Second, prices of low quality goods are more sensitive to
exchange rate shocks than prices of high quality goods. Third, in response to an exchange
rate appreciation, the composition of exports shifts towards higher quality and more
expensive goods. We test these predictions using highly disaggregated price and quantity U.S.
import data. We find evidence that in response to an exchange rate appreciation, the
composition of exports shifts towards high unit price goods. Therefore, exchange rate passthrough
rates that are measured using aggregate data will tend to overstate the actual extent
of pass-through.
- Published as "Exchange Rate Pass-Through in a Competitive
Model of Pricing-to-Market" in Journal of Money, Credit and Banking,
Supplement to vol. 41, no. 1, 2009, pp. 151–75.
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